PORTS PARTNERING WITH PRIVATE DEVELOPERS: A PUBLIC APPROACH TO REAL ESTATE DEALS AAPA Port Property Management and Pricing Seminar June 25, 2008 By Shannon J. Skinner Kirkpatrick & Lockhart Preston Gates Ellis LLP Shannon Skinner is a partner in the Seattle office of Kirkpatrick & Lockhart Preston Gates Ellis LLP, where she practices real estate and finance law. She particularly enjoys working with public entities to redevelop complex urban sites.
PORTS PARTNERING WITH PRIVATE DEVELOPERS: A PUBLIC APPROACH TO REAL ESTATE DEALS By Shannon J. Skinner Kirkpatrick & Lockhart Preston Gates Ellis LLP 1. Public Private Partnerships (“PPP,” “3P” or “Triple P”) Many ports want to redevelop their landholdings but do not have the vast amounts of money needed to undertake redevelopment of very challenging areas. Often, these properties are brownfields and have been historically industrial, so bringing residential, office and retail life to these areas is a risky proposition. Although the views may be great, the infrastructure is not. Buildings literally may be sinking on rotting piers into polluted tidelands. Ports therefore need to stimulate private investment to stretch the redevelopment dollar. Thus, “Public Private Partnerships” are quite in vogue. PPP is used loosely to mean all kinds of development where public and private intersect. This paper examines deals of the type more akin to legal partnerships, with public and private investment in a joint enterprise with expectations of returns on both sides. The role of the port typically is to develop the major infrastructure components and public amenities; the developer’s role is to build the income-producing portions (e.g., office, commercial, residential). Developers approach these deals as they do any other, with the usual expectations, the unavailability of which they may not appreciate when partnering with a public entity. Ports need to be alert to the issues and limits on their authority so they do not concede to developers’ structuring proposals (that may sound perfectly reasonable in a private context) and find themselves in the midst of something they ought not to be. Port staff and advisors need to approach these projects like the real estate developments they are and determine how, given the constraints on their authority, they can achieve their redevelopment goals without running afoul of state law. 2. Public Entities—The Constraints 2.1 Getting Paid. To start with the basics, ports are public entities and, as such, usually cannot be partners (in the legal sense) with private entities. Many states’ laws prevent states, cities and other public entities from being partners, members or shareholders of private entities (other than through authorized financial-type investments). (Some states authorize specialized public development corporations to enter into private partnerships; those are not addressed here.) For ports, this means no sharing of profit and risk with the development partner. But redevelopment does not come cheap, so how does a port obtain a return on its investment and pay its financing costs? 1
There are three basic ways to get money out of a real estate deal: (i) as a partner with an equity interest (usually not legally permitted); (ii) as a lender (may be permitted depending on the state); and (iii) by receiving fees for services, proceeds from property sales and rental income (permitted). In analyzing a real estate redevelopment, the parties need to be very precise about these possible relationships and roles. Each piece of the return to the port needs to be reviewed and put into a particular category; mushing them together can disguise problems with the deal. For example, if the developer proposes payments more in the nature of an equity return (e.g., dependent on the success of the venture), the parties may need to see if this can be restructured as a return on debt (including consideration of whether a contingent interest feature would be permitted under state law). This is because if the payments to the port are seen as being in the nature of an equity interest, the port may be deemed to be a partner of the developer, with the attendant liability. If a port is going to act as lender, what will be the debt secured? Likely it will be the purchase price for the sale of property to the developer. What will be the security for the loan-- can the port take a mortgage to secure the debt? Perhaps yes. In contrast, mezzanine financing 1 is a key element of most developer’s financing. It may be inappropriate, however, for a port to be a mezzanine lender because a port may not be able to foreclose on the pledged equity interests, as this would make it an owner of a beneficial interest in the developer at some level. In addition to exceeding the port’s statutory authority, this is also a bad idea from a liability standpoint (e.g., the port does not want to be an owner of the entity that is developing condominiums when the first homeowner claims for leaking building envelope systems are filed). If the port is going to receive fees for its services, does it have the statutory authority to collect these fees? Are these fees disguised taxes or impact fees that must be charged equally to those similarly situated? Some states have statutes governing development agreements and impact fees; these may be designed to ensure that the cost of infrastructure that benefits the public as a whole is not unfairly charged to a particular developer. What is the timing of payments and what are the remedies for failure to pay the fees? Should the port take a mortgage (junior to the project lender) to secure payment of fees? In other words, each category of proposed payment to the port should be separately specified and analyzed, from the creation of the obligation to the question of “what if?” the developer defaults. 2.2 Lending of credit. Many states have constitutional or statutory limits on the authority of public entities to make loans, lend credit or make gifts of public funds to private persons (perhaps with exceptions for the needy, ill, elderly and the like). The principle is that taxpayer money should be used for the good of the public as a whole, not for the benefit of 1 Mezzanine financing involves a constituent entity of the developer’s property-owning entity borrowing money and pledging its membership or partnership interest in the property-owning entity to the lender. Mezzanine financing can occur at any level of ownership—i.e., the borrower may be a member of a member of the property-owning entity. This type of financing is riskier and thus carries a higher rate of return. The remedies for default are to take control of the entity and effectively take control of the project. Sometimes mezzanine lenders also insist on taking a junior mortgage on the real estate to provide an alternative remedy. 2
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